- A revolving line of credit allows you to draw against a set amount for your business and only pay interest on what you borrow.
- Revolving lines of credit are useful for your company if you need capital for expansion, or want an option to cover expenses and support cash flow.
- Various types of revolving lines of credit are available – which line of credit is best for your small business?
- This article is for business owners considering opening a line of credit to help fund their company.
A revolving line of credit is a type of loan that allows you to borrow money when you need it and pay interest only on what you borrow. Then, if you pay back any of the borrowed funds before the end of the draw period, you can borrow that money again. This is what makes a line of credit revolving.
Revolving lines of credit are great tools for your business if you need working capital periodically to finance your company's growth or ongoing operations. They're also ideal if you'd like to borrow against your assets to cover expenses or refinance high-interest debt.
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What is a revolving line of credit?
Revolving lines of credit are loans that are typically secured by real estate or some other collateral, but not always. When you receive a revolving line of credit, the line is divided into two parts: a draw period and a repayment period.
During the draw period, you have the right to borrow money against your line of credit. You won't start paying interest until after you borrow against your line, and then you would make interest-only payments, which is typically each month. If you make extra payments – reducing the outstanding balance – you can borrow that money again during the draw period.
The draw period for lines of credit vary by lender, but usually end after one or two years. At that time, the lender may decide to renew your loan, extending the draw period.
Alternatively, the lender may call the loan, in which case you must repay it in full. Most often, the loan enters a repayment period, at which point the lender converts any outstanding balance to a structured business loan that is paid back through fixed monthly payments composed of both interest and principal.
[Read Related: First Small Business Loan? 11 Things to Consider]
Line of credit vs. revolving line of credit
Both lines of credit and revolving lines of credit are loans that are typically secured by either property or another asset. Both options only charge interest on the money you borrow for your company against the line, and you are responsible for interest-only payments on the outstanding balance.
The biggest difference between lines of credit and revolving lines of credit is that revolving lines allow you to reborrow any money that you use against the line, and subsequently pay back during the draw period. Lines of credit that aren't revolving do not have this feature.
Because nonrevolving lines of credit do not allow you to borrow the same funds a second time, this may also impact the length and structure of the loan's draw period. It also makes the line inherently less flexible for your business needs.
[Related content: A Guide to Choosing the Right Small Business Loan.]
Types of revolving lines of credit
Though a revolving line of credit is a fairly specific class of loan, these are some typical types of revolving lines of credit. Most of them are relatively similar and require pledging collateral worth more than the loan amount – but not all of them:
- Home equity line of credit (HELOC): A HELOC is secured by the equity you have in your residence – the value of the home above your mortgage balance. You only qualify for a HELOC if you have over 20% equity in your home, and can borrow 85% or 90% of the home's total value minus any outstanding balance on your primary mortgage. [Read Related: The Difference Between Debt and Equity Financing]
- Credit card: Though they aren't secured, and most people don't usually think of them as revolving lines of credit, that's exactly what business credit cards are. As long as you make minimum payments each month, you can pay off the items you charge for your business – within your credit limit – on your own schedule.
- Personal line of credit: A personal line of credit is similar to a HELOC, except it's secured by assets other than a house. Most personal lines of credit are secured, but some lenders provide unsecured lines of credit to highly qualified borrowers.
- Business line of credit: A business line of credit is a standard type of loan in the industry. They're issued by banks, alternative lenders and the Small Business Administration. In fact, these lines of credit are often one of the best types of business loans companies can acquire because they grant the flexibility to cover seasonal expenses or finance growth.
While most of these examples are similar, credit cards stand out. Though they are technically revolving lines of credit, funds borrowed with credit cards are almost always unsecured loans (except in the case of secured options). Because of this, credit cards have high interest rates compared to other types of revolving credit lines.
How do you get a revolving line of credit?
These are the steps for obtaining a line of credit:
- Identify potential collateral. Before you even look for a lender, the first step in attaining a line of credit is considering what assets you can pledge as collateral on a loan. If you can find collateral to secure a loan, you'll be able to secure much more favorable terms.
- Choose a type of line. Once you determine what collateral you have to pledge, you can decide whether you want to get a HELOC, a personal line or a credit card. Or, if you have been in operation for at least two years, you'll probably want a business line of credit.
- Pick a lender. Different lenders specialize in different types of loans. If you want an unsecured business line of credit, there are online lenders that can offer this. They may charge higher interest than you might pay on a secured line of credit, but you should be able to get your money fast after a short application process.
- Apply. Applications vary by lender and loan type. Some can be completed online, while others involve reviewing documents with a loan officer, or meeting with a private banker or credit union.
- Accept terms and close. If you qualify for a line of credit, your lender will provide you with a term sheet that you'll need to review before accepting terms and closing on your loan, which may involve signing a lien agreement pledging certain property as collateral.
Once you close on a line of credit, you should have access to funds within a few days. For some online lenders, it may take a few days to wire funds to your bank account, but some offer funds as quickly as the same day the loan documents are executed.
[Related content: Small Business Loan Myths Busted.]
Pros and cons of revolving credit for business
Pros
- You don't pay interest until you draw funds against the line.
- You only pay interest on the money you borrow.
- The money is available repeatedly once you pay down the balance.
- Lines of credit may charge lower interest rates than other loan types.
Cons
- Some lines, including unsecured lines, charge higher interest rates than secured lines and other types of loans.
- The draw period when you borrow against the line typically lasts 12 or 24 months; then the loan must either be renewed – for a fee – or paid in full.
- Lines may not be convertible to a structured loan for repayment. You may have to pay back the full balance all at once if the lender won't renew, and you can't find another lender to refinance the balance.
In spite of these drawbacks, revolving lines of credit have many advantages that make them ideal for small business owners. Using revolving lines of credit, you can finance outsized expenses that will grow your company.